How To Profit From The World's Next Growth Hotspot

Joel Jackson dreams of becoming the next Henry Ford. The British expatriate has moved to Kenya to launch Africa's first local automaker.

Sure, Mercedes-Benz and others have built European-engineered cars in South Africa for decades, but no one has ever designed, built and sold a 100% African car.

Jackson's Mobius Two, an $11,500 SUV, is aimed squarely at Africa's burgeoning middle class, which would like to own cars but often must pay up to 75% in excise taxes to import a foreign vehicle. You can understand why this fledgling entrepreneur is so excited as he raises money to get his business off the ground.

As a recent article in The Economist noted, the International Monetary Fund "predicts that four of the world's six fastest-growing economies in 2014 will be in sub-Saharan Africa. And for the first time in living memory, inflation will dip below the GDP growth rate." Nigeria, which is expected to pass South Africa as the region's largest economy this year, is expected to grow 7.4%, according to the IMF.

'Hopeless' No Longer
The Economist has made a major about-face when it comes to Africa. Back in 2000, its writers called Africa "hopeless," but a few years ago, it saw Africa in a new light: "Trade between Africa and the rest of the world has increased by 200% since 2000. Inflation dropped from 22% in the 1990s to 8% in the past decade. Foreign debts declined by a quarter, budget deficits by two-thirds. In eight of the past 10 years, according to the World Bank, sub-Saharan growth has been faster than East Asia's (though that does include Japan)."

Mobius Motors

The Mobius Two, an $11,500 SUV, is aimed squarely at Africa's burgeoning middle class, which would like to own cars but often must pay up to 75% in excise taxes to import a foreign vehicle.

One of the persistent complaints about Africa is a simple focus on resource extraction that really only helps China's and Africa's corrupt political leaders. But in recent years, African economies have begun to diversify: Manufacturing is growing rapidly, agricultural technology is boosting crop yields and crop storage, and in places like Ghana, Kenya and Nigeria, middle-class spending is surging.

To be sure, major impediments remain before African economies will be in peak form: Corruption is endemic, especially in oil-rich nations such as Nigeria and Angola. And though the continent's infrastructure is quickly improving thanks to massive investments from China, much more work needs to be done if Africa is to avoid the infrastructure bottlenecks that plague places like India and Brazil.

(If you are interested in reading more about economic developments in Africa, Money Watch Africa has frequent updates written by the Nile Fund's Larry Seruma.)

Expanding Range Of Options
U.S. investors have historically had few ways to invest in Africa, but the continent's maturation is likely to trigger launches of new exchange-traded funds (ETF) and mutual fund this year. For now, investors can choose from a few offerings that capitalize on the region.

This fund has $100 million in assets spread across 108 companies. Until just a few quarters ago, this fund was poorly constructed, with too heavy a weighting in too few companies and countries. Yet a shift to cap the amount of holdings gas led to much greater diversification. This fund owns a wide variety of oil drillers, banks, breweries and conglomerates, and more than 90% of the fund is invested in firms with a market value of at least $1 billion.​

More than 90% of this fund is invested in South Africa, which is home to a number of large firms that have satellite offices spread across Africa. The fund avoids heavy sector concentration, with 28% of assets in banks, but also strong positioning in consumer discretionary (21%), materials (12%), telecom services (11%), energy (9%) and consumer staples (7%).​

Some investors seek to gain exposure to Africa as part of a broader investment in what is known as frontier markets, which are the economies that fall outside of the rubric of emerging-market economies. These frontier markets have fared better than their emerging-market rivals in recent months, largely avoiding the currency crisis and trade imbalances that are hurting emerging markets.

This ETF has a predominant weighting in the petro-states of Kuwait, Qatar and the United Arab Emirates, though Nigeria, Kenya and Morocco make up nearly 20% of the fund as well. Since launching in September 2012, this fund has risen nearly 30%, slightly better than the S&P 500 in that time and far better than the beleaguered emerging-market funds.

Until the ETF category delivers more Africa-focused funds, investors should also check out mutual funds like the Nile Pan Africa C (Nasdaq: NAFCX).

This mutual fund has risen nearly 40% since a spring 2010 launch, and has broader exposure to the continent than the ETFs discussed earlier. South Africa and Nigeria constitute more than 55% of the portfolio, though Ghana, Kenya and other sub-Saharan African countries represent another 30%. African consumers are a key focus as well, with a 40% weighting, while industrial firms make up another 25%. But as is the case with many mutual funds, management fees in excess of 2% can eat away at returns.

Risks to Consider: China has poured billions of dollars into Africa, which has been a mixed blessing. The regional infrastructure is greatly improved (though still weak), and all of that money has led to concerns of further corruption. As China slowly reduces its pace of investments in Africa, growth rates may slow.

Action to Take --> Investing in Africa is tied to a vision of the future. Will the region's rising middle classes fuel a boom in new businesses that sprout up to meet newfound spending power? That was a virtuous cycle that played out in the U.S. after World War II, Europe in the 1960s, Japan in the '70s, South Korea in the '90s and China in the past decade.

African economies aim to follow that path, though they are starting from a low base as per-capita income is below $2,000 in many countries. Countries such as Kenya, Ghana and Nigeria represent the sweet spot for global investors because they are increasingly home to companies that can do battle with the continent's biggest firms based down in South Africa. If you haven't considered investing in Africa before, it's time to give this long-ignored asset class a fresh look.

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